Wednesday’s Futures Commentary: Sell-Off In Stocks Boosts US Dollar Strength And Gold Buying

Global stock markets are feeling pressure overnight following the release of a bearish earnings report from Alcoa (AA). The Street was looking for a loss because of lower demand and falling aluminum prices but the wider-than-expected loss came as a surprise to many traders.

Traders in Asia and Europe started selling after the release of the Alcoa news and no sector seems to be immune from the bearishness. Investors are becoming more defensive after the month long rally seems to be coming to an end. Appetite for risky assets is declining quickly as investors face the grim reality that the worst of the economic slump may not be over.

With the start of this year’s earning season, investors have to begin to brace themselves for more bad news to follow as these will be the first reports that reflect the damage from last fall’s credit crunch. Investors are finally getting to see how much the tight credit markets actually impacted business the past 5 - 6 months.

Since this is a short-trading week, this week’s sell-off has been triggered by light volume. Thin conditions could prevail today (Wednesday) and tomorrow as the Jewish holiday season begins. European and Asian traders will not be back from the Easter break until Tuesday which could mean even more selling pressure next week.

While the earnings reports reflect the past, there is really no way to forecast how future earnings will be impacted by the current economic situation since many firms have stopped giving guidance and analysts are at a loss as to how to view valuations.

Adding further bearishness to the markets are renewed concerns over the U.S. banking system. Negative comments earlier in the week set off selling pressure on Monday that has not let up. Concerns are being raised as to whether the U.S. banking system is even solvent. This is increasing the importance of the government’s stress tests that are taking place now. The question will be whether the government makes public the results of the stress tests or if they keep them secret to prevent runs on banks.

Additional concerns are being raised by the new International Monetary Fund report which is to be released on April 21. This report is expected to show an increase in U.S. bank toxic assets losses from $2.2 trillion in January to $3.1 trillion. An additional $900 billion in losses is expected from Asia and Europe.

All of this negative news is eroding the optimism created by the month long global stock market rally. Analysts from all over jumped on this rally as an indicator that the U.S. economy had bottomed. In reality the economy never showed signs of bottoming nor did the U.S. banking problems go away.

Technically, this could only be the first correction in the start of the next bull market but the markets have to survive at least a 50% correction of the last rally. This would put the minimum downside target in the June E-mini S&P contract at about 750.00 so brace yourself for more downside to follow.

In other news, the Securities and Exchange Commission is expected to make a ruling on the “uptick” rule shortly. Naturally investors like the news, but traders don’t. Expect the hedge funds to lobby vigorously to defeat the proposal to reinstate the uptick rule. Some feel the reinstatement of this rule will calm the markets as traders will have to wait for an uptick in price to short a stock rather than just hit bids all the way down. Although the pace of intraday declines may slow down, the change will not make short-sellers go away.

The current break in the equity markets has been sending traders into so-called safe havens such as Treasuries, gold and the U.S. Dollar.

After a sell-off earlier in the week on concerns that the Treasury may not be able to fund its current debt situation, June Bonds and June Notes have showed a rise on flight-to-safety buying. The limited size of the rally relative to the stock market break shows just how much traders have become concerned about holding treasuries at current levels.

Today’s FOMC notes will give us a clue as to how the fixed income market is thinking. If the Treasury markets become steady or trade higher then this will indicate the Fed still has work to do. A drop in prices will be a sign that the market is going to ask for higher rates later.

The Dollar remains the place to go during times of economic turmoil because it offers liquidity and safety. This week’s sell-off in equities and commodities is sending traders to the Dollar to take advantage of both. After last week’s sharp rise in European currencies due to the optimism created by the G-20 summit, investors are facing the reality this week that the rallies took place without any economic substance. Until the Euro Zone and U.K. economies begin to show signs of a recovery, look for a stronger Dollar to prevail.

Gold is showing some signs of bottoming. Oversold conditions are attracting some technically based buying but the fundamentals at this time are still expected to limit gains. The give-back in equities is also leading some traders to take their profits and put a portion back into the beaten-up gold market.

Gold bugs are still hiding out there after failing to trigger a rally to $2000 based on their forecasts of massive bank failures and hyper-inflation. The surprise that these traders weren’t counting on was IMF selling. Once the IMF is done raising cash by selling gold, there may be another leg up, but expectations of a full-blown bull market are premature.

Falling equities and a stronger Dollar are putting continuous pressure on crude oil. Speculators tried to keep this market above $50 but cooler heads prevailed and let the fundamentals dictate the market’s direction. Traders have to face the reality that the demand isn’t there to support $50 a barrel. Crude stock piles are climbing. Expectations are for an increase in today’s report. This will put inventories at a 15-year high and could accelerate a break to the downside.

The stronger Dollar is starting to have its impact on soybean and corn prices. The sell-off the last two days clearly reflects the possibility of lower prices to follow if the Dollar is allowed to strengthen. Like they did for several months before the last rally, foreign sales will dry up if the uptrend in the Dollar resumes after taking a month off. Traders are also reacting to falling stock and energy prices. Stock prices are triggering concerns about the economy while falling energy prices may be indicating less demand for biofuels.

If trading the softs complex, one has to be aware of the long-term and short-term fundamentals. Over the short-run production issues in cocoa, coffee, sugar and cotton should be supportive. Demand is expected to outstrip supply in cocoa, coffee and sugar while news that fewer acres of cotton will be planted is supportive for cotton.

Over the short-term, the value of the U.S. Dollar will be the driving force. A weaker Dollar increases demand for these Dollar priced commodities. If the Dollar rises, these markets break but only to a level where they meet expected production.

Cotton and Sugar could be the most bullish markets this year. If the economy starts to show signs of recovery then cotton should take off as demand will increase. Weather problems could also provide strong support since fewer acres will be planted. As far as sugar is concerned, a potential bull market will be determined by demand from India. Everyone knows that they have had production problems, but no one is sure when they will come to the open market for product.

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